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Financial Regulatory Developments 6th July 2017 - Final Notices

Manjeet Mohal, a former business analyst at Logica Plc, has been sentenced for insider dealing along with his neighbour, Reshim Birk. Mr Mohal was sentenced to 10 months’ imprisonment and Mr Birk to 16 months, both sentences suspended for two years.

Mr Mohal was found to have come by inside information on CGI Holdings (Europe) Ltd’s planned takeover of Logica and shared that information with Mr Birk, who then traded in Logica shares and options to make more than £100,000. The Executive Director of Enforcement and Market Oversight, Mark Steward, commenting on the case, stated that insider dealers are “more likely to be caught than ever before”.

HSBC is to voluntarily establish a redress scheme for customers who paid an unreasonable debt collection charge required by HFC Bank Ltd and John Lewis Financial Services Limited, both of which are now part of HSBC. The unreasonable debt collection charge relates to customers who fell into arrears between 2003 and 2009 and were subsequently charged a “debt collection charge” representing 16.4 per cent of the balance. The OFT previously deemed this charge to be unreasonable, as it did not reflect the actual cost of collecting the debt.

The FCA has established that approximately 6,700 customer accounts paid the debt collection charge. Those customers will be contacted by HSBC with offers of redress. In addition, during its review, the FCA identified certain customers where HFC Bank miscalculated the interest payable on their loan; HSBC has agreed to repay the overcharged interest to those customers. The FCA has estimated that, in total, HSBC will be required to pay approximately £4 million in redress to the affected customers.

In January 2017, the FCA fined Deutsche Bank AG (the bank) in London £163 million for failing to maintain an adequate AML control framework between January 2012 and December 2015. This is the largest fine that the FCA or FSA has ever imposed for AML controls failings.

The FCA considered that the bank failed to properly oversee the formation of new customer relationships and the booking of global business in the UK, thus exposing the UK to the risk of financial crime. Specifically, deficiencies in the control framework allowed thousands of highly suspicious trades to be made, covertly moving up to US$10 billion out of Russia in the relevant period.

The FCA concluded that the bank breached:

Principle 3, which required it to take reasonable care to organise its affairs responsibly and effectively; and

SYSC rules 6.1.1 R and 6.3.1 R, which required it to ensure its AML control framework was comprehensive and proportionate to the nature, scale and complexity of its activities and that it was able to identify, assess, monitor, and manage its money laundering risk.

The bank’s culture failed to instil a sense of responsibility in the London front office. While the Deutsche Bank Moscow front office carried out onboarding in relation to the trades, the Deutsche Bank London front office was ultimately responsible for ensuring that adequate CDD was carried out. The London front office failed to appreciate this.

The bank used flawed customer and country risk rating methodologies which omitted key factors in determining the applicable risk score, e.g. the lack of face-to-face contact between Deutsche Bank and customers.

The bank’s AML policies and procedures were deficient. For example, these policies did not require the gathering of information that would allow Deutsche Bank to check whether a customer’s behaviour was consistent with its profile; nor did they require the London front office to supervise the onboarding of customers of the UK branch by offices in other jurisdictions. Moreover, Deutsche Bank’s policies provided no guidance on how to evidence or establish the legitimacy of customers’ sources of wealth and funds.

The bank’s AML IT infrastructure was inadequate in that, amongst other things, it failed to provide a single authoritative repository of know your client information.

The bank lacked automated AML systems for detecting suspicious trades that could handle a high volume of transactions.

The bank failed to provide adequate oversight of trades booked in the UK by traders in non-UK jurisdictions. The FCA found that the bank’s AML functions were under-resourced and observed that Deutsche Bank had reduced the number of AML staff in both the UK and Moscow.

The FCA found that Deutsche Bank’s failings were not deliberate or reckless, and there was no evidence that anyone at Deutsche Bank was aware of the existence of, or involved in, the suspicious trading. Deutsche Bank's fine was discounted by 30 per cent because it agreed to settle at an early stage. But for the discount, the fine would have been £229 million.

The ongoing nature of the problems and the large sums involved led the FCA to impose an extremely large fine, even in the absence of any deliberate or reckless wrongdoing. Those involved in setting up or scrutinising AML procedures should give careful consideration to the details in the Final Notice. A notable aspect of this case was the lack of adequate oversight of functions being carried across different regions. This is a perennial issue for global institutions, and a particular cause for concern for those subject to the Senior Managers Regime whose areas of responsibility may be impacted by overseas staff, often in different reporting lines.

In January 2017, the Swiss financial regulator, FINMA, fined Coutts & Co. Ltd CHF6.5 million (approx. £5.2 million) for failing to conduct proper due diligence in relation to business relationships and transactions totalling US$2.4 billion associated with the Malaysian sovereign wealth fund 1MDB.

In 2009, several business relationships connected with 1MDB were transferred from Coutts Singapore to Coutts Zurich. In particular, a Coutts Zurich account was opened for a young Malaysian businessman, ostensibly to deposit US$10 million. In fact, US$700 million of 1MDB assets were deposited. The documents supporting the transaction featured obvious mistakes as to the identities of the contracting parties, and the reasons given for this transaction were inconsistent and changed retrospectively. A number of the bank’s employees raised their concerns about this transaction. For example, an employee in the Compliance unit noted in an internal email that “It would be the first time in my career that I would see a case where [in] an agreement over the amount of USD 600 Mio. or so the role of the parties had been confused”. The bank ignored these concerns and failed to seek clarification.

There followed a series of further “obviously suspicious” transactions with a total value of US$1.7 billion. Again, various parts of the bank expressed concern, but still no further due diligence was undertaken.

FINMA’s CHF6.5 million fine represents the profits unlawfully generated through these transactions. FINMA could have imposed wider-reaching measures in this case, but decided against doing so because Coutts Zurich has been winding up its licensed operations in Switzerland and has transferred many of its remaining customer assets to a private bank in Geneva. Nonetheless, FINMA is still considering initiating proceedings against responsible bank employees in relation to the same matter.

As well as being one of many recent cases illustrating the high regulatory priority given to proper anti-money laundering procedures, the case shows the importance of institutions being sensitive to employees’ legitimate concerns. Here, suspicions were appropriately raised but this did not translate into appropriate action.

The Bank of Tokyo-Mitsubishi UFJ Limited (Mitsubishi) and MUFG Securities EMEA plc (MUFG) have been fined £17.85 million and £8.925 million respectively by the PRA for their failure to be open and cooperative with the PRA in relation to a 2014 enforcement action by the New York Department of Financial Services (DFS).

Mitsubishi and MUFG failed to inform the PRA of the DFS enforcement action before DFS’s public announcement of it, falling considerably short of the PRA’s expectation that firms engage in an open dialogue and take the initiative to ensure that the PRA has all relevant information at an early stage. Further, the PRA expects firms to have in place appropriate reporting systems such that information is provided quickly and accurately, including, for international firms which operate across multiple jurisdictions, when issues arise concerning operations in one jurisdiction that may impact other jurisdictions. This is necessary in order to ensure that the regulatory responsibilities of the firm as a whole are appropriately considered.

Mitsubishi and MUFG benefited from a 30 per cent discount on their fines for agreeing to settle at an early stage.

Express Gifts Ltd, a direct mail order and online retail company, has entered into an agreement with the FCA to pay £12.5 million to 330,000 customers to whom it sold insurance products with little or no value.

Express Gifts Ltd was FCA-authorised to sell general insurance products. Between 2005 and 2015, the firm sold bolt-on insurance to customers covering against accidental damage and theft. The premiums were calculated as a percentage of the customer account balance.

After an internal quality assurance review, Express Gifts Ltd reported itself to the FCA. The firm and the FCA agreed that the insurance “did not provide adequate value to customers because although it covered all items purchased, these were predominantly items of clothing, which customers would not generally consider insuring”.

The agreement is of wider interest because it considerably extends the “treating customers fairly” principle. The FCA did not consider that the insurance products were “missold” in any conventional sense, merely that they were poor value for money. The agreement is further evidence that the FCA is prepared, in certain circumstances, to act as a price regulator.

The FCA has published a Final Notice in respect of Tesco plc and Tesco Stores Limited (Tesco), in connection with market abuse in relation to a misleading trading update. The trading update in question, published on 29 August 2014, stated that Tesco’s trading profits were expected to be in the region of £1.1 billion for the six months ending on 23 August 2014. This represented an overstatement of some £76 million. As a result of this overstatement of trading profits, the price of Tesco shares and bonds increased until Tesco corrected the false information in a statement on 22 September 2014.

The FCA considered that Tesco knew, or could reasonably have been expected to know, that the information in the 29 August 2014 announcement was false or misleading. Further, the FCA concluded that the misleading information contained within the 29 August 2014 announcement created a false market, resulting in purchasers of Tesco securities paying a higher price than they should have.

As a result, Tesco has opened a compensation scheme for all investors who acquired Tesco shares and bonds in the window of time between the 29 August 2014 statement being published and the subsequent corrective statement of 22 September 2014.

This marks the FCA’s first use of its power, under s384 of FSMA 2000, to require a listed company to pay restitution in connection with market abuse. Under FCA estimates, the total amount of compensation that Tesco will ultimately pay is £85 million, plus interest.

Interestingly, the FCA decided not to impose any further sanction on Tesco, in addition to requiring it to set up the compensation scheme.

This decision was taken as a result of the DPA entered into by Tesco Stores Limited with the SFO, for which Tesco must pay a fine of £128,992,500. This, coupled with Tesco’s cooperativeness and its acceptance of responsibility for market abuse, means there will be no further sanctions placed on Tesco.

The FCA has published a Final Notice in respect of Christopher Niehaus, a former managing director at Jefferies International Limited, failing to act with due skill, care and diligence, in breach of Principle 2. On several occasions between 24 January 2016 and 16 May 2016, Mr Niehaus was found to have shared confidential client information over instant messaging application Whatsapp with two personal acquaintances, one of whom was also a client of Jefferies and a competitor of the client to whom the confidential information related. Mr Niehaus admitted that he had no explanation for his conduct, other than wanting to impress the people he had shared the information with.

Mr Niehaus had acquired the divulged information by way of his role as a managing director (CF30) at Jefferies, as a result of which he was obliged to maintain client confidentiality. In deciding the level of fine, the FCA took into consideration the fact that Mr Niehaus had not received any identifiable financial benefit from the breach, the lack of any substantial potential effect on confidence in markets, and Mr Niehaus’s cooperation throughout the investigation. Mr Niehaus was fined £37,198; the potential fine of £53,140 was discounted in light of Mr Neihaus’s early admission of his misconduct, and as he agreed to settle at the earliest possible stage of the investigation.

In April 2017, a London jury acquitted two former junior Barclays traders, Stylianos Contogoulas and Ryan Reich, of conspiracy to defraud in connection with alleged LIBOR rigging.

The acquittals concluded a retrial of Contogoulas and Reich. At the first trial, in July 2016, a jury failed to reach a verdict on the pair, while finding four other former Barclays traders guilty of the same charge. The acquittals, which were unanimous, represent a significant defeat for the SFO not least because Contogoulas and Reich were the last of the SFO’s prosecutions relating to LIBOR, which have resulted in five convictions but a total of eight acquittals.

The SFO is now preparing for a trial in September this year of six others in connection with alleged EURIBOR manipulation.

The FCA has issued Final Notices to Niall O’Kelly and Lukhvir Thind, former Chief Financial Officer and Financial Controller (respectively) of collapsed spread betting business Worldspreads Limited (WSL).

The FCA found that various actions of Mr O’Kelly and Mr Thind constituted market abuse, contrary to s118(7) of FSMA 2000 (now replaced by Art 12(1) (c) of the Market Abuse Regulation). Mr O’Kelly was fined £11,900 (reduced from £328,100 because of serious financial hardship) and Mr Thind was fined £105,000. The FCA also found that both individuals lacked fitness and propriety, and permanently banned them from the UK financial services industry.

Mr O’Kelly had been closely involved in drafting, and had approved, the admission documents for the AIM flotation in 2007 of WSL’s parent company, Worldspreads Group (WSG). As Mr O’Kelly was aware, these documents included substantially incorrect annual accounts and omissions of key information. The FCA found that investors would have needed this information in deciding whether to purchase WSG’s shares.

The FCA also found that, when WSG ran into financial difficulty following its flotation, both Mr O’Kelly and Mr Thind knowingly falsified WSG’s losses and client liabilities (and so its cash position), rendering WSG’s annual accounts materially inaccurate, not least because they concealed client money shortfalls which by March 2011 amounted to £15.9 million.

The FCA found that Mr O’Kelly deliberately misled the market, by:

providing information as part of WSG’s request for trading on AIM (including in WSG’s AIM admissions document) which he knew was materially false;

approving WSG’s annual accounts (among other documents) knowing that they contained material inaccuracies as to profit, trade payables and cash; and

Mr Thind’s behaviour consisted of falsifying and amending trading system reports, and participating in the provision of these reports to WSL’s auditors, whilst knowing that this would have a material impact on the presentation of WSG’s financial position in its own annual accounts. Although WSL happened to be an FCA-authorised firm, the decisions are relevant to all UK listed companies. Whilst the behaviour in this case was particularly egregious, the cases show the importance of having robust controls over internal and external financial reporting, both at listing and on an ongoing basis thereafter.

The FCA has announced the reopening of its investigation into misconduct at HBOS’s Reading- based impaired assets team. The FCA suspended the investigation in early 2013 at the request of Thames Valley Police pending the completion of the latter’s investigation. That investigation, named “Operation Hornet”, led to six people receiving prison sentences for corruption, fraudulent trading and money laundering offences in connection with a scheme to lend aggressively to around 200 small businesses and charge them extortionate fees.

The FCA said its resumed investigation will focus on “the extent and nature of the knowledge of these matters within HBOS and its communications with the Financial Services Authority after the initial discovery of the misconduct”.

In January this year, the FCA also announced that it will investigate certain former HBOS senior managers to determine whether any prohibition proceedings should be commenced.

Lloyds Banking Group, which now owns HBOS, has set aside £100 million to compensate the victims for their economic loss, distress and inconvenience.

The case is one of a number of long-running matters, concerning different institutions, where criminal investigations have led to the postponement of regulatory investigations. The latter may then be restarted many years later. Inevitably memories will be less fresh at this point, demonstrating the importance of good document preservation procedures. Careful consideration should also be given to taking proofs of evidence, having due regard to the possibility that these may not be privileged.